Investors, Investment Strategies and Regulation Flashcards
What are the characteristics of the money market?
-trading short-term securities that are very liquid
-the traded securities have a low default risk, are bought and sold in large denominations leading the main market participants to be central banks, commercial banks and large firms and their maturities range from 1 day to 1 year
-there is electronic trading
-active secundary markets
What is the purpose of the money markets?
Is to manage short-term needs (liquidity).
Why could the commercial banks replace the money markets in managing liquidity?
They have better knowledge of the clients’ characteristics and benefit from efficiency gains processing information
Why do money markets exist when they could be replaced by commercial banks?
Commercial banks have to comply with certain regulations and pay costs and have advantages dealing with asymmetric information problems, but when not serious, the costs are more relevant.
why do participants invest in the money markets?
Returns higher than those of alternative investments, reduce the opportunity costs of having very liquid assets
What are the main market participants?
- Governments - use to get short term liquidity - issue treasurie bills - and manage the cycle of taxes
-Central banks - open market operations to control the economy’s money supply and management of the yield curve
-Commercial banks - issue deposit certificates and repurchase agreements, hold the greatest part of the debt securities issued by treasuries, manage the liquidity and trade on clients’ behalf
-Large firms - issue most of the commercial paper, can access via mutual funds
What is the interbank money market?
Bank-to-bank money transactions that take place in the money market. (markets where both parts are banks)
What are the different instruments traded in the money markets?
-Treasury bills - maturities up to 1 year, very liquid with low transaction costs and almos non-existente default risk
-Commercial paper - issued by large firms to get short term liquidity, have lower costs
-Certificates of deposit - issued by banks, have a specific interest rate and maturity, but can be bought or sold before that
Repurchase agreements - sale of securities with an agreement to buy them back at a price previously agreed on.
What are the characteristics of the stock market?
-trading of long-term securities to obtain long term financing / do long term investments
-main market participants are households, treasuries and firms
What are the main differences between common stock and preferred stock?
In common stock we can have voting rights, rights to buy new shares in the same proportion owned when issued, no priviledge in dividend payment and they are only paid when company has excess profits, and are the last in line for claiming assets in bankruptcy. As for preferred stock, there is no voting rights or pre-emptive rights, dividends tend to be garanteed and paid before common stocks, and in case of bankruptcy, they are paid after debtholders and before common stockholders.
Why is it difficult to compute the stocks’ value?
They have no direct intrinsic value and are representing other possible valuable rights which suffer from uncertainty
Why do the different asset pricing models create an indeterminacy problem?
Because we don’t know which model is the most correct to use or they might be based on unrealistic assumptions.
What is the equity risk premium?
The historical difference between the returns of stock market and bond market on that economy; also considered the expected equity premium or required (for investing in stocks instead of a risk-free investment
What does a higher return on the stock market means?
On average, means the investors have invested more on the bond market or treasury market. The bonds a treasure bills will be underpriced, and in the long run, the investors benefit.
What do high historical equity risk premium suggests?
that investors are risk averse and this varies over time - tens to be higher in times of greater uncertaity
When stocks enter an upward phase, the risk premium will increase, but higher stock prices translate into lower returns.
